Keep a close eye on your small-cap investments

Keep a close eye on your small-cap investments

(Filed: 07/03/2004)

Last week's bout of profit taking begs a tactical question: what is the best strategy going forward?

Military action in Iraq brushed aside investors' gloom a year ago and since then there has been a sharp increase in the appetite for shares, with the best performers also being the most speculative. This was a rational response due to a two-way relationship between shares and companies that you need to appreciate to deal successfully.

Financially stretched companies - technology and cyclicals especially - were able to harness the outbreak of greed (suppressed ahead of the war) to re-capitalise their balance sheets. Shares rose in recognition that the companies were better able to seize prospects. As progress is now being reported and forecasts upgraded, re-ratings have continued. Yet last week's market retreat shows this approach - which has paid off brilliantly to date - is being questioned.

I am not suggesting that you prune all your winners, just that you should be aware of a shift in sentiment. This applies especially to the smaller end of the market.

An interesting aspect is the recent share price performance of Edinburgh Smaller Companies investment trust. After a sustained period of poor performance, its board changed the manager to Standard Life Investments. Ironically some of the previous manager's small and speculative shares will have turned up with the market. In the early months of Standard Life's management its lower-risk strategy under-performed.

But on a medium-term view this team's approach looks better suited to the evolving scenario, especially if interest rates creep up. I think this is why the trust's shares bucked last week's general profit taking and edged up to 55.75p.

I no longer buy investment trusts because I prefer stock picking. Yet I would recommend Edinburgh Smaller Companies if you are seeking a good risk-adjusted return. I expect the shares to continue creeping up as investors become aware of the portfolio rebalancing. With key holdings such as Telecom Plus, Majestic Wine, Topps Tiles and Hornby, the new strategy favours proven companies near the top of the small cap league. Their average capitalisation is £270m and the broad aim is "to buy tomorrow's larger companies today".

There's an element of momentum investing when using criteria that include earnings upgrades, director and institutional buying and rising share prices. I know I've made "acts of omission" with such shares that often seem fairly priced yet have a habit of delivering consistent gains. Yes, there have been more exciting short-term gains in recovery and cyclical shares, but for consistent returns I recognise merit in Standard Life's approach.

Companies in strong or consolidating sectors, with a proven record, ought to be able to cope with higher interest rates and come into favour. It also seems fair to anticipate a narrowing in the trust's current discount to net assets from 24 per cent.

Bumpy ride at Ramco

Ramco Energy shows why the new manager of this investment trust has reduced its exposure to smaller oil companies, where investors can have a bumpy ride.

As a trailblazer in Azerbaijan, Ramco multiplied investors' money, but further progress became difficult and its shares slumped. The focus switched to Eastern Europe and then the Celtic Sea, where the Seven Heads gas project won support among brokers. The Aim-listed shares doubled to above 400p last year but have plunged to 100p after a sudden decline in well-head pressure. It's possible that this will be resolved and the shares will rally, but that is not a gamble I'd take.

I was surprised brokers were so keen about a share based principally on one asset. Nothing is certain in this industry; it's best to pick shares involving a spread of projects.

An article by Tom Winnifrith 'No oil exposure? You're mad' on the home page of www.advfn.com clarifies why you should bear this sector in mind. I agree with him that brokers' estimates for oil prices are too conservative and that profit and net asset value forecasts will have to be increased. There are short and long-term reasons why oil should be represented in a portfolio.

Ructions at Planestation

Planestation has yet to rid itself of board ructions. It was frustrating last year that the shares in the company (previously known as Wiggins) were suspended for so long during refinancing talks. When this happens in recovery situations it's a fair bet the financiers are looking for changes on the board. That's understandable when they're putting in big money, but smaller shareholders may be excused for wondering if there'll be a company left.

Thankfully, the capital raising was agreed and I joined other holders supporting the 4p-a-share open offer. Raising nearly £50m transformed the company's prospects. I imagined there were plenty of companies interested in doing business with PlaneStation (or in carving up its property assets) but they were waiting for the refinancing.

Things then went quiet in January/February, with no new chairman confirmed. This made me wonder if the board might be at each other's throats again.

At least there was good news for the group's Manston airport in Kent, which struck an agreement with EUjet. Other airlines are expected to follow, and there are plans for a fast rail link between London and Manston. It looks like the airports-to-property business model could really start to generate value.

I am holding firm after the shares have doubled to 5p since I took my stake. But it concerns me that action to remove the chief executive may presage a carve-up bid that throws away long-term potential.